Understanding the Differences Between Active & Passive Losses

It’s time to take another look at the rules for rental properties for your deduction and a few of the tax rules to ensure that you qualify. Generally since the mid to early 80′s the IRS has limited what one can deduct for rental properties based upon your level of participation.

Generally, the least stringent of the qualification rules is under the active participation standard. To qualify a taxpayer needs to participate in making management decisions such as qualifying new tenants, deciding rental terms and the approval of required expenditures while acting in a bona fide and significant sense. If you qualify under this standard then your real estate losses are generally ruled to be passive and to limited to a maximum of $25,000. Also to meet this requirement taxpayers (counting a spouses interests) are required to own at least 10% of the equity/ownership percentage in a given property. The $25,000 maximum is phased out starting at $100,000 of adjusted gross income and is totally phased out after adjusted gross income exceeds $150,000.

Certain real estate professionals, who qualify, can treat real estate activities as non-passive and therefore not subject to the above limitation. To qualify a taxpayer, or their spouse, must spend more than one-half of their personal services actively in the furtherance and performance and provide material participation in real estate activities. Also the taxpayer, or their spouse, must perform more than 500 hours of service during the tax year in the real estate activity in which they actively participate. Generally this exception is applied on a property by property basis, however a taxpayer may elect to this standard to all interests as a single activity for purposes of satisfying the material participation standards and requirements.

Carefully evaluate how you are treating your real estate properties and ensure that you are correctly applying these standards against your properties and to treat the deductions for them accordingly.